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25 February 2015
Agenda Item No_____________
Treasury Management Strategy Statement 2015/16
Summary:
This report sets out details of the Council‟s treasury management
activities and presents a strategy for the prudent investment of the
Council‟s surplus funds.
Options Considered:
Alternative investment options are continuously appraised by the
Council‟s treasury advisors, Arlingclose and all appropriate options are
included within this Strategy.
The Strategy represents an appropriate balance between risk
management and cost effectiveness. An alternative strategy might be
to invest in a narrower range of counterparties or for shorter periods.
Interest income is likely to be lower as a consequence, but with a
reduced risk of losses from counterparty default. Investing in a wider
range of counterparties or for longer periods may increase interest
income, but with an increased risk of loss from defaults.
Conclusions:
Recommendations:
Reasons for
Recommendation:
The preparation of this Strategy Statement is necessary to comply
with the Chartered Institute of Public Finance and Accountancy‟s
Code of Practice for Treasury Management in Public Services.
That the Council be asked to RESOLVE that The Treasury
Management Strategy Statement is approved.
The Strategy provides the Council with a flexible treasury strategy
enabling it to respond to changing market conditions and ensure the
security of its funds.
LIST OF BACKGROUND PAPERS AS REQUIRED BY LAW
(Papers relied on to write the report, which do not contain exempt information and which are not
published elsewhere)
Cabinet Member(s)
Ward(s) affected: All
Cllr W Northam
Contact Officer, telephone number and email: Tony Brown, 01263 516126, tony.brown@northnorfolk.gov.uk
1.
Introduction
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1.1
In April 2010 the Council adopted the Chartered Institute of Public Finance and
Accountancy‟s Treasury Management in the Public Services: Code of Practice 2011
Edition (the CIPFA Code) which requires the Council to approve a treasury management
strategy before the start of each financial year.
1.2
In addition, the Department for Communities and Local Government (CLG) issued
revised Guidance on Local Authority Investments in March 2010 that requires the
Council to approve an investment strategy before the start of each financial year.
1.3
This report fulfils the Council‟s legal obligation under the Local Government Act 2003 to
have regard to both the CIPFA Code and the CLG Guidance.
1.4
The Council has invested substantial sums of money and is therefore exposed to
financial risks including the loss of invested funds and the revenue effect of changing
interest rates. The successful identification, monitoring and control of risk are therefore
central to the Council‟s treasury management strategy.
1.5
The treasury strategy set out in this report supports the budget for 2015/16 which is
included as a separate report elsewhere on this agenda.
2.
Context
2.1
Economic background: The UK economy has enjoyed a period of growth as a result of
domestically-driven activity and strong household consumption. Growth is becoming
more balanced and the greater contribution from business investment should support
continued, albeit slower, growth in Gross Domestic Product (GDP). Inflation is likely to
remain low in the short-term. There have been large falls in unemployment but levels of
part-time working, self-employment and underemployment are significant and growth in
earnings remains weak and below inflation.
2.2
The Bank of England‟s Monetary Policy Committee (MPC) has focused on both the
degree of spare capacity in the economy, and the rate at which this will be used up. Two
MPC members having voted for a 0.25% increase in rates at each of the meetings from
August 2014 onwards and some Committee members have become more concerned
that the economic outlook is less optimistic than at the time of their August Inflation
Report.
2.3
Credit outlook: Two European Union (EU) directives will be incorporated into UK
legislation in the coming months and will place the burden of rescuing failing EU banks
disproportionately onto unsecured local authority investors. The Bank Recovery and
Resolution Directive promotes the interests of individual and small businesses covered
by the Financial Services Compensation Scheme and similar European schemes. The
Deposit Guarantee Schemes Directive extends the compensation schemes to large
companies. The combined effect of these two changes is to leave public authorities and
financial organisations (including pension funds) as the only senior creditors likely to
incur losses in a failing bank after July 2015.
2.4
The continued global economic recovery has led to a general improvement in credit
conditions since last year. This is evidenced by a fall in the credit default swap spreads
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of banks and companies around the world. However, due to the above legislative
changes, the credit risk associated with making unsecured bank deposits will increase
relative to the risk of other investment options available to the Council.
2.5
Interest rate forecast: The Council‟s treasury management advisor Arlingclose
forecasts the first rise in official interest rates in August 2015 and a gradual pace of
increases thereafter, with the average for 2015/16 being around 0.75%. Arlingclose
believes the normal level for the Bank Rate post the economic crisis will be in the range
of 2.5% to 3.5%. The risk that the rate will actually be higher is weighted more towards
the end of the forecast period. Against this, the Eurozone weakness and the threat of
deflation have increased the risks to the durability of UK growth. If the negative
indicators from the Eurozone become more entrenched, the Bank of England are likely
to defer rate rises to later in the year.
2.6
For the purpose of setting the budget for 2015/16, it has been assumed that treasury
investments together with the loans to housing associations will achieve an average
interest rate of 2.2%.
2.7
At the end of December 2014, the Council had total investments of £19.025m, details of
which are set out in Appendix?
3.
Borrowing Strategy
3.1
The Council is currently debt free and its capital expenditure and financing plans do not
currently imply any external borrowing requirement over the forecast period.
Investments are forecast to fall to £12.9m in 2018/19 as capital receipts, capital grants
and other NNDC reserves are used to finance capital expenditure. If changes to the
capital programme are approved during 2015/16 which will require financing from
external borrowing, an amendment to this Strategy will be taken to Full Council for
approval.
3.2
The balance available for treasury investments is after taking account of £3.5m in loans
anticipated to be made to Housing Associations for service related purposes under the
Local Investment Strategy. These will be financed from capital receipts and £1.7m of
internal borrowing which will result in a future Minimum Revenue Provision (MRP)
charge being made to the revenue account.
3.3
In addition, the Council may occasionally borrow short-term in accordance with prudent
treasury management activity.
4.
Investment Strategy
4.1
The Council had an average balance of £27.6m invested to 31 December 2014. This
represents income received in advance of expenditure, plus balances and reserves held.
An average balance of £19.4 is anticipated in 2015/16.
4.2
The CIPFA Code and the DCLG Guidance require the Council to invest its funds
prudently, and to have regard to the security and liquidity of its investments before
seeking the highest rate of return, or yield. The Council‟s objective when investing
money is to strike an appropriate balance between risk and return, minimising the risk of
incurring losses from defaults and the risk of receiving unsuitably low investment income.
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4.3
With the increasing risk and continued low returns from short-term unsecured bank
investments, the Council aims to further diversify into more secure and/or higher yielding
asset classes during 2015/16. This is especially the case for the estimated £12m that is
available for longer-term investment. In the past the majority of the Councils surplus
cash has been invested in short-term unsecured deposits and money market funds, so
this diversification will represent a significant change in strategy over the coming year.
4.4
The Council may invest its surplus funds with any of the counterparty types in table 1
below, subject to the cash limits (per counterparty) and the time limits shown. Further
details are included from paragraph 4.5 onwards.
Table 1: Approved Investment Counterparties and Limits
Credit
Rating
UK
Govt.
AAA
AA+
AA
AAA+
A
ABBB+
BBB or
BBBNone
Pooled
funds
Banks
Unsecured
Banks
Secured
N/A
N/A
£1.5m
5 years
£1.5m
5 years
£1.5m
4 years
£1.5m
3 years
£1.5m
2 years
£1.5m
13 months
£1.5m
6 months
£0.75m
100 days
£0.75m
next day only
£0.75m
6 months
£3m
20 years
£3m
10 years
£3m
5 years
£3m
4 years
£3m
3 years
£3m
2 years
£3m
13 months
£1.5m
6 months
£1.5m
100 days
n/a
Government
Corporates
Registered
Providers
£ Unlimited
50 years
£3m
50 years
£3m
25 years
£3m
15 years
£3m
10 years
£1.5m
5 years
£1.5m
5 years
£1.5m
5 years
£0.75m
2 years
N/A
N/A
£1.5m
20 years
£1.5m
10 years
£1.5m
5 years
£1.5m
4 years
£1.5m
3 years
£1.5m
2 years
£1.5m
13 months
£0.75m
6 months
£1.5m
20 years
£1.5m
10 years
£1.5m
10 years
£1.5m
10 years
£1.5m
5 years
£1.5m
5 years
£1.5m
5 years
£0.75m
2 years
n/a
n/a
n/a
£1.5m
25 years
£50,000
5 years
£0.75m
5 years
£5.0m per fund
Note: The limits for banks apply equally to building societies as they are no longer treated any
differently.
4.5
Credit Rating: Investment decisions are made by reference to the lowest published longterm credit rating from Fitch, Moody‟s or Standard & Poor‟s. Where available, the credit
rating relevant to the specific investment or class of investment is used, otherwise the
counterparty credit rating is used.
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4.6
Banks Unsecured: Accounts, deposits, certificates of deposit and senior unsecured
bonds with banks and building societies, other than multilateral development banks.
These investments are subject to the risk of credit loss via a bail-in should the regulator
determine that the bank is failing or likely to fail. Unsecured investment with banks rated
BBB or BBB- are restricted to overnight deposits.
4.7
Banks Secured: Covered bonds, reverse repurchase agreements and other
collateralised arrangements with banks and building societies. These investments are
secured on the bank‟s assets, which limits the potential losses in the unlikely event of
insolvency, and means that they are exempt from bail-in. Where there is no investment
specific credit rating, but the collateral upon which the investment is secured has a credit
rating, the highest of the collateral credit rating and the counterparty credit rating will be
used to determine cash and time limits. The combined secured and unsecured
investments in any one bank will not exceed the cash limit for secured investments.
4.8
Government: Loans, bonds and bills issued or guaranteed by national governments,
regional and local authorities and multilateral development banks. These investments
are not subject to bail-in, and there is an insignificant risk of insolvency. Investments
with the UK Central Government may be made in unlimited amounts for up to 50 years.
4.9
Corporates: Loans, bonds and commercial paper issued by companies other than banks
and registered providers. These investments are not subject to bail-in, but are exposed
to the risk of the company going insolvent. Loans to unrated companies will only be
made as part of a diversified pool in order to spread the risk widely.
4.10
Registered Providers (treasury investments as opposed to loans made for services
related purposes): Loans and bonds issued by, guaranteed by or secured on the assets
of Registered Providers of Social Housing, formerly known as Housing Associations.
These bodies are tightly regulated by the Homes and Communities Agency and, as
providers of public services, they retain a high likelihood of receiving government
support if needed.
4.11
Pooled Funds: Shares in diversified investment vehicles consisting of any of the above
investment types, plus equity shares and property. These funds have the advantage of
providing wide diversification of investment risks, coupled with the services of a
professional fund manager in return for a fee. Money Market Funds that offer same-day
liquidity and aim for a constant net asset value will be used as an alternative to instant
access bank accounts, while pooled funds whose value changes with market prices
and/or have a notice period will be used for longer investment periods.
4.12
Bond, equity and property funds offer enhanced returns over the longer term, but are
more volatile in the short term. These allow the Council to diversify into asset classes
other than cash without the need to own and manage the underlying investments.
Because these funds have no defined maturity date, but are available for withdrawal
after a notice period, their performance and continued suitability in meeting the Council‟s
investment objectives will be monitored regularly.
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4.13
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Risk Assessment and Credit Ratings: Credit ratings are obtained and monitored by the
Council‟s treasury advisers, who will notify changes in ratings as they occur. Where an
entity has its credit rating downgraded so that it fails to meet the approved investment
criteria then:
•
no new investments will be made,
•
any existing investments that can be recalled or sold at no cost will be, and
•
full consideration will be given to the recall or sale of all other existing investments
with the affected counterparty.
4.14
Where a credit rating agency announces that a credit rating is on review for possible
downgrade (also known as “rating watch negative” or “credit watch negative”) so that it
may fall below the approved rating criteria, then only investments that can be withdrawn
on the next working day will be made with that organisation until the outcome of the
review is announced. This policy will not apply to negative outlooks, which indicate a
long-term direction of travel rather than an imminent change of rating.
4.15
Other Information on the Security of Investments: The Council understands that credit
ratings are good, but not perfect, predictors of investment default. Full regard will
therefore be given to other available information on the credit quality of the organisations
in which it invests, including credit default swap prices, financial statements, information
on potential government support and reports in the quality financial press. No
investments will be made with an organisation if there are substantive doubts about its
credit quality, even though it may meet the credit rating criteria.
4.16
When deteriorating financial market conditions affect the creditworthiness of all
organisations, as happened in 2008 and 2011, this is not generally reflected in credit
ratings, but can be seen in other market measures. In these circumstances, the Council
will restrict its investments to those organisations of higher credit quality and reduce the
maximum duration of its investments to maintain the required level of security. The
extent of these restrictions will be in line with prevailing financial market conditions. If
these restrictions mean that insufficient commercial organisations of high credit quality
are available to invest the Council‟s cash balances, then the surplus will be deposited
with the UK Government, via the Debt Management Office or invested in government
treasury bills for example, or with other local authorities. This will cause a reduction in
the level of investment income earned, but will protect the principal sum invested.
4.17
Specified Investments: The CLG Guidance defines specified investments as those:
•
denominated in pound sterling,
•
due to be repaid within 12 months of arrangement,
•
not defined as capital expenditure by legislation, and
•
invested with one of:
o
the UK Government,
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o
a UK local authority, parish council or community council, or
o
a body or investment scheme of “high credit quality”.
4.18
The Council defines “high credit quality” organisations and securities as those having a
credit rating of A- or higher that are domiciled in the UK or a foreign country with a
sovereign rating of AA+ or higher. For money market funds and other pooled funds “high
credit quality” is defined as those having a credit rating of A- or higher.
4.19
Non-specified Investments: Any investment not meeting the definition of a specified
investment is classed as non-specified. The Council does not intend to make any
investments denominated in foreign currencies, nor any that are defined as capital
expenditure by legislation, such as company shares. Non-specified investments will
therefore be limited to long-term investments, i.e. those that are due to mature 12
months or longer from the date of arrangement, and investments with bodies and
schemes not meeting the definition on high credit quality. Limits on non-specified
investments are shown in table 2 below.
4.20
Table 2: Non-Specified Investment Limits
Cash limit
Total long-term investments *
Total investments without credit ratings or rated below A- *
Total investments with institutions domiciled in foreign
countries rated below AA+
Total non-specified investments *
* Includes £5m invested in the LAMIT Pooled Property Fund
4.21
£12m
£10m
£2m
£15m
Investment Limits: The Council‟s revenue reserves available to cover investment losses
are forecast to be £9 million on 31st March 2015. In order to ensure only an acceptable
level of these reserves will be put at risk in the case of a single default, the maximum
that will be lent to any one organisation (other than the UK Government) will be £3
million. A group of banks under the same ownership will be treated as a single
organisation for limit purposes. Limits will also be placed on fund managers,
investments in brokers‟ nominee accounts, foreign countries and industry sectors as
below:
Table 3: Investment Limits
Cash limit
Any single organisation, except the UK Central
Government
UK Central Government
Any group of organisations under the same ownership
£3m each
unlimited
£3m per group
Any group of pooled funds under the same management
£5m per manager
Negotiable instruments held in a broker‟s nominee account
£10m per broker
Foreign countries
£5m per country
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Registered Providers
£7.5m in total
Unsecured investments with Building Societies
£3m in total
Loans to unrated corporates
£3m in total
Money Market Funds
£12.5m in total
4.22
Liquidity management: The Council maintains a cash flow forecast on an Excel spread
sheet to determine the maximum period for which funds may prudently be committed.
The forecast is used to minimise the risk that the Council is forced to borrow on
unfavourable terms to meet its financial commitments.
5
Treasury Management Indicators
5.1
The Council measures and manages its exposures to treasury management risks using
the following indicators.
5.2
Security: The Council has adopted a voluntary measure of its exposure to credit risk by
monitoring the value-weighted average credit score of its investment portfolio. This is
calculated by applying a score to each investment (AAA=1, AA+=2, etc.) and taking the
arithmetic average, weighted by the size of each investment.
Target
Portfolio average credit score
6.0
A credit score of „6‟ equates to a long-term rating of „A‟ (Fitch and S&P) or A2 (Moody‟s).
5.3
Liquidity: The Council has adopted a voluntary measure of its exposure to liquidity risk
by monitoring the amount of cash available to meet unexpected payments within a
rolling three month period, without additional borrowing.
Target
Total cash available within 3 months
5.4
£3m
Interest Rate Exposures: This indicator is set to control the Council‟s exposure to
interest rate risk. The upper limits on fixed and variable rate exposures, expressed as
the proportion of net principal borrowed (i.e. fixed rate debt net of fixed rate investments,
will be:
2015/16
Estimate
%
2016/17
Estimate
%
2016/17
Estimate
%
Upper Limit for
Fixed Interest
Rate Exposure
(100%)
(100%)
(100%)
Upper Limit for
Variable Interest
(100%)
(100%)
(100%)
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Rate Exposure
5.5
As the Council‟s investments exceed its borrowing, these calculations have resulted in a
negative figure.
5.6
The purpose of the limit is to ensure that the Council is not exposed to interest rate rises
on any borrowing which could adversely impact the revenue budget. Variable rate
borrowing can be used to offset exposure to changes in short term rates on investments.
However, the Council does not anticipate entering into a borrowing during the period of
the Strategy. These limits therefore allow maximum flexibility for fixed or variable rate
investments and investment decisions will ultimately be made on expectations of interest
rate movements as set out in the Strategy. Fixed rate investments and borrowings are
those where the rate of interest is fixed for the whole financial year. Instruments that
mature during the financial year are classed as variable rate.
5.7
Maturity Structure of Fixed Rate borrowing:
5.8
This indicator highlights the existence of any large concentrations of fixed rate borrowing
needing to be replaced at times of uncertainty over interest rates and is designed to
protect against excessive exposures to interest rate changes in any one period, in
particular in the course of the next ten years.
5.9
It is calculated as the amount of projected borrowing that is fixed rate maturing in each
period as a percentage of total projected borrowing that is fixed rate. The Council is
currently debt free and does not anticipate new borrowing in 2015/16 (other than for
short periods for cash flow purposes). However, should the Council require to borrow for
the long-term, the limits below provide the flexibility to borrow fixed rate loans in any of
the maturity bands below.
Lower Limit
for 2015/16
%
0
Upper Limit
for 2015/16
%
100
12 months and within 24 months
0
100
24 months and within 5 years
0
100
5 years and within 10 years
0
100
10 years and above
0
100
Maturity structure of fixed rate borrowing
under 12 months
5.10
As the Council has no external debt, the limits above allow flexibility to borrow new loans
in the most appropriate maturity band.
5.11
Principal Sums Invested for Periods Longer than 364 days: The purpose of this
indicator is to limit exposure to the possibility of loss which may arise as a result of the
Council having to seek early repayment of the sums invested. The limits on the total
principal sum invested to final maturities beyond the period end will be:
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2015/16
2016/17
2017/18
£12m
£12m
£12m
6
Policy on Use of Financial Derivatives
6.1
The CIPFA Code requires authorities to clearly detail their policy on the use of financial
derivatives in the annual strategy. These instruments are used to manage risks (such
as interest rate swaps to manage interest rate risks), and can be embedded into loans
and investments, or are standalone. The general power of competence in Section 1 of
the Localism Act 2011 removes much of the uncertainty over local authorities‟ use of
standalone financial derivatives.
6.2
The Council will only use standalone financial derivatives (such as interest rate swaps)
where it can be clearly demonstrated that they reduce the overall level of financial risks
that the Council is exposed to. They will only be used after seeking expertise, a legal
opinion and ensuring officers have the appropriate training for their use.
6.3
Embedded derivatives will not be subject to this policy, although the risks they present
will be managed in line with the overall treasury risk management strategy.
7.
Investment Training
7.1
The needs of the Council‟s treasury management staff for training in investment
management are assessed as part of the staff appraisal process. Staff regularly attend
training courses, seminars and conferences provided by Arlingclose and CIPFA.
8.
Treasury Management Advisors
8.1
The Council employs a Treasury Management Advisor, Arlingclose Limited, to provide
advice and information on counterparty creditworthiness, treasury strategy, economic
updates and technical support on all treasury matters. The Treasury Advisory Service is
periodically subject to tender to ensure the Council receives a quality service and
Arlingclose successfully tendered for a new contract commencing 1 April 2011. The
option to extend the contract for a further year has been taken by the Council and the
current contract now expires on 31 March 2016.
9.
Financial Implications and Risks
9.1
The budget for investment income in 2015/16 is £426,390 based on an average
investment balance of £19.4 million at an interest rate of 2.2%. This rate assumes the
Council‟s £5m investment in the Local Authorities Property Fund makes an income
distribution of 5%, and loans under the local investment strategy earn 3.5%. The rates
which can be earned on other of investments included in this Strategy are anticipated to
remain low during 2015/16 and an average of 0.5% is assumed in the budget figure.
9.2
The effectiveness of the Treasury Strategy will have a significant impact on the budget
and finances of the Council. Investment decisions will be made based on the Council‟s
forecast of interest rate movements. If actual rate movements prove to be very different,
there will be implications for the investment return achieved.
9.3
It is not possible to predict with certainty the future movements in interest rates. The
Strategy must therefore be flexible enough to allow the Council to respond to changing
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market conditions. It must also enable the Council to respond to future changes in
legislation.
9.4
The security of the Council‟s investments is of prime concern, and the Strategy must
ensure that, as far as possible, the Council‟s investments are repaid in full, with interest
earned, on the due date.
10.
Sustainability – None as a direct consequence of this report.
11.
Equality and Diversity – None as a direct consequence of this report.
12.
Section 17 Crime and Disorder considerations – None as a direct consequence of
this report.
Appendix ?
Investment Position as at 31 December 2014
Amount
£
Average
Rate
%
Managed in-house
Short-term Investments
- Term Deposits with Banks & Building Societies
- Certificates of Deposit
Long-term Investments
- Covered Bonds with Building Societies
Managed externally
- Money Market Funds
- LAMIT Pooled Property Fund
Total Investments
5,000,000
3,000,000
0.6
0.77
4,500,000
1.23
1,525,000
5,000,000
19,025,000
0.39
5.5
2.05